Notice something? During the low tax eras (Reagan-Bush41 and Bush43), we witnessed lower growth rates. During the Clinton Administration – which began with its fiscally responsible policies with a tax rate increase – we saw strong growth. Maybe part of the explanation has to do with the impact on national savings from fiscal irresponsibility justified by phony free lunch promises.

I have a bit of a problem with the evidence here. To get the gist of my objection, take the following quiz:

Which one of these time periods did not include a recession?

a. 1980QIV to 1992QIV

b. 1992QIV to 2000QIV

c. 2000QIV to 2006QIV

If you answered b, you win the gold star. And if you knew that, are you really surprised that the period from 1992 through 2000 had higher average growth than the other two periods, which did include recessions? Suppose we instead make the comparisons including only the expansion years of the Reagan-Bush41 and Bush43 administrations? Here's what you get:

From 1983 to 1989, average annual real GDP growth = 4.3%.

From 1992 to 2000, average annual real GDP growth = 3.7%.

From 2002 to 2006, average annual real GDP growth = 2.9%.

You could just as well look at those numbers and conclude that potential GDP growth -- measured cycle to cycle -- is declining through time. And if you accept pgl's characterization of irresponsible policy, followed by responsible policy, followed by irresponsble policy, you might then conclude that policy has very little to do with that trend.

Perhaps you would want to argue that I shouldn't exclude recessions because the absence of a downturn in the 1992-2000 period is itself evidence of the superior growth effects of the fiscally responsible policies of the Clinton administration? Let me try to talk you out of that with a few more questions:

1. Do you really want to blame the Reagan fiscal policies for the 1980-82 recessions -- which are almost universally attributed to the Volcker Fed's fight against double digit inflation inherited from the policies of the 1970s?

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Macroblog asks, "Do you really want to blame the Reagan fiscal policies for the 1980-82 recessions -- which are almost universally attributed to the Volcker Fed's fight against double digit inflation inherited from the policies of the 1970s?"

The first of the two dips, no.

But let's stop and think a moment. Why did Volcker push rates up to such punishing levels? Did it have anything to do with deficits?

If you answered yes to the latter, then Reagan has to take the blame for the second, terribly damaging dip of the recession.

One can argue that Reagan's increase of military spending far beyond what he had promised in the campaign was necessary. I would not. One can argue that his tax cuts were essential as a growth stimulus. I would not. One can even argue that the out-of-control budgetary extravaganza that David Stockman describes was a necessary price to be paid for getting the changes Reagan wanted. I would not.

But one cannot argue that whatever the h--l Reagan was doing didn't to get paid for (it wasn't and hasn't been), which is an important reason for the Fed's severity.

Well I am not going to be the 'one' to argue with Charles. I would not and I do not.
No.
Why should I rescue Volcker in preference to Reagan? or pgl in preference to our fine host David?
If you answered politely to the latter, that it is always civil to side with the host no matter how uncompassionately he posts (and fresh from declarations of sensitivity, people!), give yourself a ...gold star? Really?
I cannot be bought by these gold star thingies, you? No, ok give yourself a good slap to the forehead and know that your first swing at it was just a warm-up...to your mighty swath which would be about measuring GDP and not GDP growth rates, about the respective income distributions in those periods (ok, "expansions" look good but pgl battles the political thugs who are as arbitrary as he is.) and the increasing debt.

Unfortunately, I don't have time to dig up the actual numbers, but a few years ago I computed annualized real GDP growth as a function of Democratic or Republican Presidents, going back to about 1920-1930 (I don't remember the exact year). I also tried lagging it by 1 or 2 years (assuming there is a delay from when the president takes office to when his policies can have an effect).

The result was quite dramatic. In all cases (0, 1, 2 year lag), the annualized real GDP growth was significantly higher during Democratic presidents.

I'm not sure exactly what it proves, but it was a much larger sample than the one referenced in this blog entry.

You have a valid point that the recessions can distort the comparisons. But the recovery period immediately after a recession also distort comparisons. So if you are going to remove the recession years from the comparisons you should also remove the snap-back years of the recovery that are just as much a distortion.

For the 1980s this implies your should remove 1984 and 1985 when growth was 4.5% and 4.1%. Without these two observations your average growth for the Regan years is much lower. However, you do not get this distortion for the Clinton years since the early recovery period only had 3.3% real gdp growth in 1992.

You are correctly pointing out one data distortion only to replace it with an even more distorted comparison.

Let me try to explain why I chose to focus on the very narrow issue I did. Many Net debates try to deal with too much and end up resolving nothing. But on the issue of the twin recessions of the early 1980s, we actually have fairly good inside evidence as to why things unfolced as they did. We have David Stockman's account from inside the Administration. We know that there was tension between conservatives (GOP president, GOP Senate, nominally Democratic but boll weevil-controlled House) and the Fed. We know that monetarism was driving monetary policy, and that fiscal policy was very loose (see www.time.com/time/magazine/article/0,9171,954012-3,00.html, for example). So, there's not really much question that interest rates were held high because of deficits, nor is there any question that Republicans had the upper hand in government, nor is there any question that high interest rates diminish growth.

If David will re-consider this one point, we could move onto the next and the next and maybe come to a conclusion.

Thank you for casting that 'one' into the drink Charles. Seriously, one can be a pain in the butt, you know?
And thank you for not enumerating your points for us flow-an-go guys who have trouble even with "points" and "moving forward" sometimes even to conclusions....you know?
Ok, now you know.
This is not a debate...I am unable to act as a fair and balanced moderator and am not about to concede that role to anyone else, you?
I accept 'discussion' when sober and polite, nearly civil...like now.
I appreciate your detail and your bravery at accepting Stockman's account as the veritable truth, but I also appreciate spencer's skill in unraveling this "comparison" of economies over broad horizons and see serious problems of referential opacity...much to the chagrin of economists who need to feel that certain eras were managed better than others...and that their profession, still in its infancy, counts for something.

If you measure from the recession bottom there has been no significant difference in real gdp under Clinton and Bush II. Moreover, both experienced weaker growth then Reagan did in the 1980s and he experienced weaker growth then Kennedy/Johnson did in the 1960s.

However, when you look at the composition of growth there are significant differences between Clinton and Bush. Under Clinton investment made a much larger contribution while under Bush it has been consumption and housing that led growth.

To be honest, I do not much care about the debate over why growth is that much different under democratic and republican presidents. However, I do care that the theory that supply-side economics leads to greater investment and higher standards of living is simply incorrect as it has been practiced under Republican administrations over the last quarter century.

It is very difficult to compare. With Reagan, he was starting out in such a hole, you had to get some parts of the economy started, let alone to stop sputtering. He also increased defense spending, and at the same time Congress increased social spending as well. This greatly inflated the deficit more than it normally would have.

Clinton decreased defense spending and increased taxes. Remember the peace dividend? He also increased social spending. Both Bush I and Clinton started from a firm base, and good consumer confidence. Expectations were higher than they were under the beginning of the Reagan presidency. Bush I was not a good fiscal policy planner, and stupidly raised taxes and lowered expectations, inducing a recession.

None of these Presidents had to deal with what Bush had to deal with, a crashed stock market, an unprecedented terrorist attack. Bush's largest mistake came by not using his veto pen to cut the spending of an unchecked Republican Congress.
Hastert and Frist also should assume a lot of the blame.

The interesting thing to look at is what will happen in the future. Congress is debating a new tax bill, and it looks like they will raise taxes, and change a lot of the tax code. If expectations change, it will have a far greater effect on fiscal policy than a deficit or surplus.

One thing is clear, people respond to incentives. If you lower taxes, they will produce more. Raise them and you change their incentives. The one bill I have read about changes the AMT and rates of tax over 250K. You will see a lot of people seeking tax shelters that make above 250K. Cayman Islands anyone?

You'd think people writing about economics would understand the difference between correlation and causation. Do tax cuts and deficits cause recessions, or could it maybe just be the other way around? Do Republicans cause slower growth, or do Republicans get elected to clean up the messes created by Democrats (see Reagan, Ronald)?

Jeff says Reagan started in a deep hole but he should check out my second reply to David (which David provides a link to in his update). According to the CBO, the GDP gap was only 2.4% as of 1980QIV. From mid-1980 to mid-1981, real GDP grew by about 4.3%. Maybe Jeff is thinking about where the economy was at the end of 1982. But didn't Reagan become President in early 1981?

My estimate of spencer grows boundlessly it seems (iz he gettin help, people?) and I feel compelled to fall in behind the (political) defusing sagacity of remarks like this:

"To be honest, I do not much care about the debate over why growth is that much different under democratic and republican presidents. However, I do care that the theory that supply-side economics leads to greater investment and higher standards of living is simply incorrect as it has been practiced under Republican administrations over the last quarter century."

And not, say, (the lame, and media cultivated and propagated, and reminder that some of us were born on Thursday) remarks like this:

"None of these Presidents had to deal with what Bush had to deal with, a crashed stock market, an unprecedented terrorist attack. Bush's largest mistake came by not using his veto pen to cut the spending of an unchecked Republican Congress.
Hastert and Frist also should assume a lot of the blame."

The reason political parties act as they do is because the only relevent statistic we seem to focus on is GDP growth over their term.

I am thinking Ravi Batra provides the best summary of Greenspn era crap. According to Batra, the Reagan tax cuts were payed for by a huge increase in the most regressive of taxation, social security. People were fooled into thinking they were putting money aside for retirement while, just like now, they are funding a renegade tax-cut-for-the-rich, budget busting, debt induced spurt in GDP.

Like the Reagan-Bush-Cheney-Rumsfelt-Greenspan real estate scam and debt splurge of the 80's, the Bush-Cheney-Rumsfelt-Greenspan real estate scam and debt splurge of the 00's will end badly, ie; recession and deficits.

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November 21, 2006

Do These Numbers Add Up?

Today's Wall Street Journal has a long, and interesting, article (page A1 of the print edition) on where the Democrat-controlled Congress might take economic policy if they have their druthers. On the let's-pay-for-things side of the ledger:

The Senate Finance Committee, with the blessing of both parties' leaders, is circulating a list of ways to shrink the "tax gap" between taxes owed and taxes actually paid. Most are aimed at upper-income taxpayers, such as requiring stock brokers to report not only the price a client got for shares, but also the original purchase price paid.

Boosting taxes on upper-income Americans would reduce disparities and provide revenues for other attacks on inequality. Raising the top two tax rates, now 33% and 35%, by a single percentage point would yield $90 billion over five years, the Congressional Budget Office estimates.

Another favorite Democratic target is the lower tax rate -- a maximum of 15% -- on capital gains and dividends.

But then there is this list, which includes expanded tax breaks for low-income workers...

Enlarging the earned-income tax credit, viewed by many economists as a smart alternative to a higher minimum wage, is an option likely to figure in Democratic tax deliberations. The credit offers up to $4,536 to a family with two or more children to offset payroll taxes that the working poor pay. And it offers a cash bonus if the credit exceeds taxes paid, rewarding low-wage workers without raising employers' costs...

... expanded social insurance for displaced workers...

One direct response to workers' anxiety is expanded government programs to cushion the fall of those who lose jobs in today's rapidly changing economy...

Lori Kletzer of the University of California at Santa Cruz and Howard Rosen of the Peterson Institute for International Economics in Washington, for instance, would offer eligible dislocated workers up to half the difference between weekly earnings at their old and new jobs, up to $10,000 a year. This isn't cheap: They put the price tag at between $2.6 billion and $4.3 billion a year, financed through general tax revenues or an expanded payroll tax.

... larger expenditures on education...

Democrats are focused on doing more to help Americans pay for college, especially important since the typical college grad earns 45% more than the typical high-school grad. Ms. Pelosi's platform calls for making up to $12,000 a year in college tuition tax-deductible -- or the equivalent in a $3,000 tax credit -- as well as cutting interest rates on student loans and increasing the maximum Pell Grant for low-income students to $5,100 from $4,050.

A coalition that spans the political spectrum is pushing more government support of Pre-K education. The case: Low-income children are behind when they arrive at kindergarten and never catch up; spending more on them sooner would have a big payoff.

... and incentives to induce more private saving

... such as replacing current tax breaks for retirement savings with universal 401(k) accounts into which the government would match family savings -- a 2-to-1 match for low-income families, 1-to-1 for middle income families and perhaps 0.5-to-1 for high-income families.

These are all responses to very legitimate concerns -- how do we encourage more saving, how do we ensure opportunities to develop the skills that so clearly separate the haves from the have-nots, how should we view society's responsibilities to people who are harmed by economic change through no fault of their own? And though the ideas above may or may not be the best approaches to dealing with these questions, they are certainly worthy of discussion.

But how should that discussion proceed? An awful lot of people seem to feel that just reversing past tax cuts will somehow lead us to the promised land, but the arithmetic looks pretty shaky to me. That's why I think this is a good place to start:

New House Speaker Nancy Pelosi has vowed to restore a 1990s rule requiring new spending to be offset by spending cuts or tax increases...

First, a means to institutionalize priority setting. Then, on the specifics of those priorities, we can talk.

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Paygo? That thing that George W. Bush decided to dismantle so he could claim he was cutting taxes as he also raised spending. No, the Dems promises likely don't add up but then we would never hold the Bush Administration to such a standard when we have Fuzzy Math.

"Institutionalize priority setting"? That's a mouthful I wish I'd heard about 6 years ago! I would hope encouraging "more savings" is a "legitimate concern", but I haven't seen any evidence to suggest it. In SoCal, I'm STILL receiving 2-3 credit card offers weekly with enticements of 0% interest for 15 months on xfers & purchases. Potential home buyers here are still beseiged with no-doc, no $$ down financing offers, stores are still offering no interest on purchases until 2008. Have you checked what interest rates Banks are offering?
So, here's my rhetorical question of the day:
How does the FED decide 5.25% Fed Funds rate is near that midpoint where it encourages neither spending nor saving? We're not a manufacturing economy anymore and most distributors long ago switched to just-in-time inventory management. (Many of these now use Wall St., not their local bank, to fund their overhead. My guess is, the FED is VERY slow to change, that it's one thing to push for the HUGE changes repealing Glass-Steagall brought, but it still prefers to conduct its oversight in the same old way that worked poorly in the past.
I'm as tired of banging the "accountibility" drum as you are of politically charged rhetorical argument, but I think in times of Administration AND Congressional irresponsibility, the FED at the least should at the least use it's pulpit to call for responsibile legislation & fiscal budgeting. Yet, it doesn't. It's clear AG HUGELY damaged our long-term economic prospects, BUT he's gone. Where is BB's plan to institute & bring regulatory controls of our financial sector into the 21st century? If the FED doesn't want sole responsibility for independent oversight of our economy it serves no public benefit. Encouraging the FED to lead "would be a GREAT beginning".

pgl and bailey, my friends -- C'mon. There are new kids in town. Don't you think its time to stop harping on the past? Time to start thinking about the new agenda, not the purported failures of policymakers who are no longer relevant.

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October 23, 2006

Laffer's Defense?

A fair amount of (gleeful?) keystroking was instigated last week by a Washington Post article that included this "confession":

Robert Carroll, deputy assistant Treasury secretary for tax analysis, said neither the president nor anyone else in the administration is claiming that tax cuts alone produced the unexpected surge in revenue. "As a matter of principle, we do not think tax cuts pay for themselves," Carroll said.

In fact, one of the reasons to have some confidence that the most recent round of tax cuts in the United States did not pay for themselves is that the hard work of incorporating those incentive effects upon which the Laffer curve hinges has been done. Kash had the story, at The Street Light:

The tax cuts may indeed have stimulated some economic growth. In 2003 the Republican Congress convened a panel of economists (under the authority of the Joint Committee on Taxation, or JCT) to estimate exactly how much of a positive impact on tax revenues this feedback effect would provide, using a technique called "dynamic scoring" to measure the overall cost of the tax cuts.

This JCT study concluded that there would indeed be positive revenue effects from the economic growth that the tax cuts would stimulate, to the tune of some $30 or $40bn per year. But it turns out that the negative revenue effects of the tax cuts are a bit larger than that.

The "bit larger" there is facetious. And, I think, the presumption that tax cuts won't pay for themselves is a good general principle. But it is does have its limits. Alex Harrowell, for example, unearths this interesting tidbit at A Fistful of Euros:

... the Socialist government of Ferenc Gyurcsyany came up with a simple plan to cut the deficit from 10.1 per cent of GDP to something more reasonable.

Essentially, he decided to tax the rich until the pips squeaked. More accurately, he decided to tax industry until the pips squeaked, introducing a new 4 per cent “solidarity tax” on company profits...

... there is no sign of Laffer-type behavioral responses generating revenue increases from the tax cut elements of these reforms..."

I take no issue with that conclusion, but this, from the paper, bears emphasis:

But this paper—like the practical developments it addresses—is not about the HR flat tax.

Particularly in the United States, the term “flat tax” is associated with Hall and Rabushka (1983 and 1985; HR)... In effect, the HR flat tax is a consumption-type, origin-based value-added tax (VAT) collected by the subtraction method, supplemented by a (nonrefundable) tax credit against labor income.

And that really, really matters. Several years back, I was part of a team that simulated the effects of the HR flat tax, and similar forms of fundamental tax reform. We found that in the most straightforward version of this type of tax reform, the shift from something like our present income-based tax system to an HR-like consumption-based system would require a tax rate on labor-income of 21.4 percent in order to keep revenues from falling. Over time, as the growth effects of removing capital taxation took hold in our experiments, the tax rate required to maintain revenue neutrality fell by 2 percentage points. (The payroll tax rate required to finance social security benefits fell slightly as well). In these experiments, then, really fundamental reforms did indeed generate "Laffer-type" effects, at least in the long run.

What's the moral to the story? I guess it's that, even though the conventional wisdom is usually right, we probably shouldn't take for granted that it is always so. There's a good reason to keep playing the game.

UPDATE: Kash notes that the flat tax experiments I describe are about the efficiency gains of revenue-neutral fundamental tax reform and not that general cuts in tax rates raise revenues. And right he is. We are both agreed that the answer to what happens to revenues after any particular tax change depends on the both the nature and context of the change. And I'll agree that once that point is recognized, the Laffer curve is not an idea that conveys much additional insight.

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September 14, 2006

I Second The Motion

Congressmen Mike Pence and Eric Cantor want to index for inflation the cost basis of assets that are charged the capital gains tax rate. Great idea.

I concur. In a 1999 National Bureau of Economic Research volume titled The Costs and Benefits of Price Stability, Martin Feldstein contributed a paper with this conclusion:

The analysis developed [in this paper] implies that the annual gain that would result from reducing inflation from 2 percent to zero would be equal to between about 0.76 percent of GDP and 1.04 percent of GDP.

How that translates into a long-run benefit depends critically on assumptions about how to discount future gains to the present, among other things. With Feldstein's preferred assumptions, the gain is as high as 40 percent. That can be debated, but suffice it to say that even with quibbles about the exact assumptions to apply -- and other details of the analysis -- the net gains would be pretty darn big if Professor Feldstein's analysis is anywhere close to correct.

In the paper, Feldstein conceded:

... adverse effects of the tax-inflation interaction could in principle be eliminated by indexing the tax system... As a practical matter, however, such tax reforms are extremely unlikely.

Fair enough, but the real reason to prefer indexation to "reducing inflation from 2 percent to zero" may be that reducing the rate of inflation to zero might not be such a good idea. During his first tour of duty on the Board of Governors of the Federal Reserve System, Ben Bernanke made these remarks:

I need to introduce the idea of the optimal long-run inflation rate, or OLIR for short. (Suggestions for a catchier name are welcome.) The OLIR is the long-run (or steady-state) inflation rate that achieves the best average economic performance over time with respect to both the inflation and output objectives.

Note that the OLIR is the relevant concept for dual-mandate central banks, like the Federal Reserve. Thus it is not necessarily equivalent to literal price stability, or zero inflation adjusted for the usual measurement error bias. Rather, under a dual mandate, a strong case can be made that, below a certain inflation rate, the benefits of reduced microeconomic distortions gained from price stability are outweighed by the costs of too frequent encounters of the funds rate with the zero-lower-bound on nominal interest rates...

... studies of the costs of very low inflation (such as the supposed effects of downward nominal wage rigidity on the allocation of labor) have found that these costs are also largely eliminated at inflation rates of about 2 percent...

At the very least, the gains of reducing the distortion on capital returns would be diminished by pushing the rate of inflation lower than would otherwise be "optimal." Indexing is the better approach.

... we should note that this paper is entirely an argument for reducing capital taxation. Inflation is essentially incidental to the argument -- reducing inflation is simply a means of reducing capital income taxation.

That's a fine point, and the Feldstein article does duly note that the appropriate way to analyze a tax rate reduction is to insist on revenue neutrality (at least in a present value sense). You may think that capital income taxes are just fine where they are. I won't object (at least not here). But even so, is it really a good idea to use monetary policy to engineer tax policy? Isn't the right approach to insulate statutory tax rates from the potential influence of inflation, and leave fiscal policy decisions to Congress?

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You left off the Andy Roth for a zero capital gains rate. Good move as that would be a stupid idea. But why not take this indexation idea a lot further and extend it to interest income (and expenses). After all, this idea was supported not just by Milton Friedman but also by the late James Tobin.

Sorry to be redundant but shouldn't we agree FIRST on a definition for inflation, THEN on a measurement for it that can be supported by a representative population sampling?
Wouldn't it benefit us all if the Fed did more to encourage us to save and less to rationalize its huge increases in money supply?

In his abstract, Feldstein mentions the revenue loss from seignorage but not the revenue loss from the capital gains tax. It seems to me this would be a critical issue: if you reduce the inflation rate, reported capital gains go down, and the government collects less revenue, which must be made up by other taxes, by cutting spending, or by borrowing, any of which options would have detrimental effects that might outweigh the advantages cited by Feldstein. What does he assume about how the government would make up for this revenue loss?

bailey -- the current indexation of brackets is based on the CPI. I suppose that might create some bias, but franky I've never been convinced that they are all that big. So the CPI is good enough for me.

knzn -- Feldstein acknowledges that his costs must be measured agains all sorts of other costs including lost siegniorage, transition costs of tighter monetary policy and the like, and concludes that his calculations suggest the gains swamp whatever costs addressing those issues might bring. His estimates of those changes didn't go unchallenged -- Alan Auerbach, for example, noted that his estimates of the benefits of reducing capital gains are quite a lot bigger than those Feldstein derived.

From my point of view, I think it is reasonable to just imagine indexing capital income (from all sources) and adjusting existing statutory rates to compensate for the revenue windfall. That is not Feldstein's game, of course, but I think if you are interested in removing the influence of inflation on the tax code it might be best to decouple that from other types of tax reform (such as shifting from capital-based taxation to wage or consumption based taxation).

Dave, The Cpi was good enough for me too, BEFORE the Boskin recommendations were enacted. But, that 25% reporting adjustment was one adjustment too many. The CPI is such a critical indicator that the change has had huge economy-wide impact.
I think our previous CPI readings would have begged for greater Fed attention when less would have done a whole lot more & BB would not be facing the dilemma he is.
Have a great weekend.

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I hope the answer is none, because one of the premises is irrelevant. The question is not have the tax cuts been financed by spending cuts, but rather will they be financed by spending cuts. Brad's expectation may be reasonable given the politics of the situation, but you obviously cannot draw conclusions by assuming a condition that has yet to be determined.

Today, Professor DeLong responds:

It's possible that there are huge spending cuts relative to GDP in our future. It's not terribly likely.

Uh, gee. Isn't that exactly what I said? OK, I'll always accept the possibility I just wasn't clear enough, but I'm not sure where this comes from:

If I were Macroblog, I would say, instead, that the Bush tax cuts are good for growth because in response to the tax-cut magic the Growth Fairy will appear, wave her wand, and instantaneously boost labor productivity by 5%. That seems more likely than Macroblog's scenario.

I wasn't aware that I was proposing any scenario. I was really making a pretty simple, and minor, observation. The Treasury analysis in question was based on assumptions about what policy might be in the future, not on what policies are already in place (which I think everyone agrees are incomplete). Brad built a syllogism on a premise related to current and past policy, which is quite beside the point of the analysis. If the premise had been "The Bush tax reductions will not be financed by spending restraint..." I would have been perfectly happy (although I might still have suggested that opinions remain distinct from facts).

In the balance of my original post I waxed enthusiastic about Menzie Chinn's assertion that seriously evaluating spending reductions requires that those cuts be explicitly identified. And as I noted above, I did in fact say that the "Brad's expectation [that taxes will have to be increased] may be reasonable" and coupled that with a call to combine that conclusion with advocacy for a broader look at how the tax system can be made more conducive to enhanced economic performance. How that adds up to a belief in some magic tax-cut Growth Fairy is beyond me.

Brad goes on:

... only tamed economists give politicians credit for policies the politicians won't propose. It muddies the waters and degrades the quality of debate to do so.

I think that there is a knee-jerk tendency to assume that any objection to someone's criticism of a policy is the same thing as an endorsement of that policy. It is not. So, for the record: I endorse no blanket solution to bringing the government's budget back into balance. I am highly skeptical of the proposition that it can be done by reducing spending alone. I am also highly skeptical of the proposition that simply reversing the Bush tax cuts is the best possible answer. And I am 100% in agreement with the DeLong appeal that "the Bush administration propose a policy mechanism--like the Budget Enforcement Act, say--to cut discretionary and entitlement spending, title by title, as shares of GDP starting in 2010". There a quality debate awaits.

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RE: "I think that there is a knee-jerk tendency to assume that any objection to someone's criticism of a policy is the same thing as an endorsement of that policy. It is not."
Hey, I'd appreciate being addressed as Mr. Knee Jerk, thank you. I IMMEDIATELY assume this is a misdirection ploy of a partisan.
It makes no sense to me that anyone, Socrates excluded (and he wasn't Fed senior staff), would jump into a charged argument he didn't support to dispute a criticism of that argument.

Pardon the interruption but many of us economists on the left would be all for a package of spending cuts and tax increases. The problem is that this White House is opposed to either this bipartisan approach and seemingly incapable of finding any significant spending cuts. Given the fact that the General Fund deficit is near $600 billion (see CalculatedRisk for repeated reminders), trimming $30 billion in pork and waster from Federal spending is about 5 cents on the dollar. Maybe a few other cuts can be found, but the notion that we will not have to reverse some of the Bush tax "cuts" (really deferrals) is simply not credible.

bailey -- I might have some blinders on about this, but I really didn't think my comments about Brad's post would be construed as support for anything in particular (especially since I thought I was clear about what I did support later on in the post -- and thanks for the support o that MG). Maybe part of the confusion is that I approach my contributions on this blog from a slightly different angle than, for example, my friend pgl. Because I am in fact "Fed senior staff" I try pretty hard to not bring partisan opinions to the argument. It's no secret, I think, that I lean to the right (just as pgl and DeLong lean to the left), so my opinions may often align with proposals of right-leaning partisans. But I assure you I am not in the business of carrying water for anyone but myself.

I would make the same comment, in essence, about pgl's comment. My enthusisam for what the Treasury department is trying to do with dynamic analysis should not be construed as support for the policies they are analyzing. I've yet to see the policy that I would actually support, exactly because I agree that the policy options ought to be more explicitly articulated. I do, however, think it is incorrect to say we will have to reverse some of the Bush tax cuts. Even if you believe that revenues will have to be increased -- and in my post I did indicate that I tend to that belief -- there is no reason that it has to be from undoing the specific provisions in the original Bush tax legislation. It may or may not be the sensible thing to do, but logic does not compel it.

Which brings me to my criticism of Brad's post. Chalk that one up to the fact that in my heart and soul and blog my perspective is that of a teacher. I thought Brad's comments were illogical in the context of the debate. Because I was rounding up blog commentary on the point -- and because DeLong is smart guy who I recommend that my students read -- I thought it appropriate to call him out on that one.

(John -- Sorry I had to delete your post. It was off-point, but the real problem was that you included a commercial appeal which is verboten here. I would be glad to accommodate your thoughts in some other fashion.)

I think that those that are talking about raising taxes are traveling with blinders on. The facts are pretty straight forward. Since the Bush tax cuts took effect, (and if you go back in time the Reagan tax cuts) government revenues have INcreased. The richest part of the population is paying more than ever. There is more economic activity, and GDP has increased.

I would agree that we need to cut spending. I think that the Congress has done a horrible job in this regard, and the Bush administration has not put any restraints on them. I was hopeful that a Republican president and Republican Congress would decrease the size of the governement, and decrease the size of government outlays. Notwithstanding the war on terror, they have not done that.

Suppose we had cut actual domestic, not just proposed budgeted, spending by 5%. Where would we be then? We would still have a deficit due to the war, it just wouldn't be as large. But then the left wing would trot out all the stories in a media blitz about how Uncle Sam is leaving poor people in the lurch. Did it ever occur to them that able bodied people might help themselves?

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July 26, 2006

A Teachable Moment

The Treasury Department has released a new analysis of "the President’s proposal to permanently extend the tax relief provisions enacted in 2001 and 2003 that are currently set to expire at the end of 2010." It is attracting its share of controversy, of course, but interestingly the argument does not seem to be about its reliance on "dynamic analysis using a model that accounts for the effects of this greater work effort, increase in savings and investment, and improved allocation of resources on the size of the economy."

The Treasury's main analysis assumes that lower tax revenue will over time be accompanied by reduced spending on government consumption. But the report also shows what happens if spending cuts are not forthcoming. In this alternative scenario, a permanent extension of recent tax relief is assumed to lead to an eventual increase in income taxes.

The results are strikingly different. Instead of increasing by 0.7% in the long run, GNP now falls by 0.9%.

Says DeLong:

What proportion of students will be able to follow the syllogism?

Tax relief is good for growth only if the tax reductions are financed by spending restraint.

The Bush tax reductions have been financed not by spending restraint but by borrowing.

Therefore:

The Bush tax reductions have been bad for growth.

I hope the answer is none, because one of the premises is irrelevant. The question is not have the tax cuts been financed by spending cuts, but rather will they be financed by spending cuts. Brad's expectation may be reasonable given the politics of the situation, but you obviously cannot draw conclusions by assuming a condition that has yet to be determined.

Menzie Chinn has a better point:

It is important to understand that there is no welfare calculation undertaken, despite the fact that under certain conditions, GNP is higher than under baseline. That is because undertaking a welfare analysis would require taking a stand on the utility associated with government spending on goods and services. So even if one were to take the Treasury's high end estimate for the long run steady state effect, the answer to the question of whether tax cuts are desirable depends upon the utility associated with spending on civil servant wages, bridges, and body armor.

Very true, and wouldn't it be nice to have a serious discussion about those trade-offs? And while we are at the business of pointing out that either spending or taxes have to give, why not put even more aggressive tax reform back on the table. Carroll and Mankiw report:

According to the Treasury analysis, a permanent extension of the recent tax cuts leads to a long-run increase in the capital stock of 2.3%, and a long-run increase in GNP of 0.7%.

Contrast those numbers with these, from a Treasury report released a few months ago on the dynamic effects of tax reform s that would, to varying degrees, shift the tax burden away from saving and capital accumulation:

.. models suggest that the [Growth and Investment Tax] recommended by the [President's Advisory Panel on Federal Tax Reform] could lead to long-run increases in the capital stock ranging from 5.6 to 20.4 percent and long-run increases of national income ranging from 1.4 to 4.8 percent. The simulated growth effects of the [Simplified Income Tax] plan were considerably smaller, with long-run increases in the capital stock ranging from 0.9 to 2.3 percent and national income increases ranging from 0.2 to 0.9 percent. The growth effects of the [Progressive Consumption Tax] were the largest of the three plans, with long-run increases in the capital stock ranging from 8.0 to 27.9 percent, and long-run increases in national income ranging from 1.9 to 6.0 percent.

Now we're talking real money. I'd have a lot more sympathy for the call to raise taxes rather than cut spending if the former came with an advocacy for some real tax reform.

[The] final paragraph of the report is interesting because it shows that the better way through tax policy to increase long-run economic growth is to target directly at marginal tax rates, whereby people make their economic decisions, and not to mess with credits, deductions, phase-outs, phase-ins, etc, which have little economic value.

I want to point out that Lesson 1 summarizes the effect of the policy on the level of output, a movement to a new steady state. It is not a change in economic growth... Quoting from the report, "In the steady state, per-capita growth in the model is equal to a constant rate of technological change." I've missed something somewhere. The commentary is about changes in economic growth, not changes in the level of output, so it would be helpful to see the connection between tax cuts and the (constant) rate of technological change explained further since an increase in the rate of technological change is needed to increase the growth rate of per capita output.

I think the answer is that Carroll and Mankiw are being a little fast and loose with their language. If the long-run level of income is higher under a particular policy, then it must be the case that the growth rate of income is higher than it would otherwise be for some period of time along the transition from the old policy to the new one. In the short-run or medium-run, the growth rate of the economy is stimulated, even though there is no impact on growth in the long run.

UPDATE: pgl adds his thoughts at Angry Bear. I especially think his admonition that there is often a tension between short-run stimulus and long-run capital formation is worth taking to heart.

TrackBack

» Tax Cuts Debate from Economic Investigations
Macroblog has a nice summary of the discussion, so far, on the US Presidents proposed extension of tax cuts, A Teachable Moment, starting with the initial comments of Mankiw Ive linked to previously, in the Dynamic Tax AnalysisR... [Read More]

Tracked on Jul 27, 2006 9:11:54 AM

» A Teachable Moment from TruePress
Macroblog takes a look at the various economics blog reactions to the recently announced Treasury Department calculations of the GNP effects of permanently extending the 2001 2003 tax cuts.
... [Read More]

Tracked on Jul 27, 2006 9:22:22 AM

Comments

Thanks for summarizing the economist blog debate so far. After I read the Treasury report, I was rather shocked at the bait and switch arguments in it. More over at Angrybear.

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July 08, 2006

Dieting And Tax Cuts

The Laffer Curve offers the false promise that we can cut taxes without making any sacrifice on the spending side, and that's simply not true. It's the economic equivalent of arguing that you can lose weight by eating more.

I think that may be an apt comparison, though perhaps for slightly different reason than Dr. Wheelan intends. As someone well-acquainted with the need for a diet, I am often given the advice to not starve myself in an attempt to lose weight, as doing so will cause my internal metabolic regulators to kick into survival mode, thus sustaining those pesky pounds I'm trying to shed. In other words, in some circumstances, I might lose weight by eating more!

The appropriate response would be that this observation may apply in limited circumstances, but it does not apply in most cases, including mine: One more bag of potato chips is not my path to a sleek physique. It is not that theory absolutely rules out losing weight by eating more. It is simply that the situations in which it is so are few, and the advice is irrelevant in most situations.

That, in fact, seems to me what Dr. Wheelan is saying. Here is another passage from his article:

In fairness to Mr. Laffer, there's nothing wrong with this theory. It's almost certainly true at very high rates of taxation. If you consider the extreme, say a 99 percent marginal tax rate, then the government will probably not be collecting a lot of revenue. To begin with, citizens are going to hide as much income as possible. (The more honest ones will turn to barter and avoid the tax system entirely.) And no one is going to rush out and take a second job or build a factory if they get to keep only $1 of every $100 that they earn.

So it's entirely plausible that slashing tax rates from 99 percent to 30 percent could increase government tax revenues. It would deflate the black market and provide a huge new incentive to work and invest.

But:

But here's the problem when we take Laffer's theory and try to apply it in the U.S.: We don't have a 99 percent marginal tax rate. Or 70 percent. Or even 50 percent. We start with low marginal tax rates relative to the rest of the developed world. (Yes, I understand that it may not feel that way after the check you wrote last month.)

So cutting the tax rate from 36 percent to 33 percent is not going to give you the same kind of economic jolt as slashing a tax rate from 90 percent to 50 percent. There's no huge black market to be shut down, no big supply of skilled workers to be lured back into the labor market, and so on.

I often tell students that a great many -- maybe most -- disagreements among economists are not about theory, but about how to quantify our economic models. And the answer to that can only be adjudicated by evidence that rarely delivers a clean verdict.

I am very definitely with those who argue that, as a general proposition applied to U.S. policy today, you should not bet on tax cuts financing themselves. The burden of proof is, in my opinion, on those who would argue otherwise. But I'm always willing to listen, and entertain the not inconsiderable possibility that I'm wrong.

Best summary of the Laffer curve I have read. Many simply poo-poo the curve, and treat laffer as some kind of nut. Seems as if many cannot discuss the curves nuances (movent at the curves top is probably somewhat flat).

"This week, the White House will revise its fiscal year 2006 budget deficit estimate to roughly $300 billion, a significant reduction from its January forecast of $423 billion.

Our calculations suggest that the federal budget deficit this year will be approximately $260 billion. This is down from $318 billion in FY-05 and $413 billion in FY-04.

Strong gains in tax receipts have overwhelmed increased federal spending. Congressional Budget Office (CBO) data show that federal tax receipts during the nine months ending in June were 12.8% above the same period in FY-05. Withheld income taxes increased 9% in June from last year; non-withheld income tax payments surged by 20%, while corporate tax receipts grew by 17%.

If federal receipts continue to grow in a similar fashion during the final three months of this fiscal year, they will climb to an all-time high of $2.4 trillion dollars, $275 billion above last year, $400 billion more than in 2000, and equal to 18.5% of GDP.

Federal spending is on track to increase 9% this year, and will end the year at 20.7% of GDP, up sharply from the 18.4% share in 2000. If federal spending had remained at 18.4% of GDP this year, the US would have recorded a small surplus of $21 billion."

...

"Since 1930, there have only been 19 years in which the tax share of GDP was at or above 18.5%, and in the past 20 years, tax receipts have averaged 18.3% of GDP. This means tax receipts in 2006 will be above historical norms.

Since the tax cut was passed in May 2003, US GDP has expanded by more than 20%, or roughly $2.2 trillion. To put this in perspective, we have added more to GDP in the past three years than an entire China (current estimate of $1.9 trillion in annual GDP)."

If it wasn't for the war, we'd probably be close to balanced, or surplus, I don't know the #'s.

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March 26, 2006

Odds And Ends

Another quarter begins at the University of Chicago Graduate School of Business, and I have once again cleverly fallen behind on my reading, giving me the excuse to introduce some of my favorite weblogs to new students, via this review of things I should have talked about last week.

SPECIAL BRAIN-LOCK UPDATE: Above I hat-tipped A Fistful of Euro's David Weman for a Guardian article "bemoaning the rising tide of protectionism" (my words). Unfortunately, the Guardian article that does the bemoaning is not the one David cites. I had in mind an earlier article by James Surowiecki. David was pointing to another article, by Daniel Davies, arguing that capital controls do not count as protectionism. Double hat-tip to David for keeping me on the straight and narrow. (Oh, and by the way -- I'm with Surowiecki.)

» Carnival of the Economists from The Big Picture
Over at Macroblog, Dave Altig collects lots of Odds And Ends from the week's economic writings. He's a one man Carnival of the Economists. Looks like it took hours to put together. If you are looking for additional sources of economic writing and discu... [Read More]

I'll add a few on-line print business columnists for your insatiable readers. O.C.Register's Jon Lansner is always on top of the socal economy, & I think Dallas Morning News' Danielle DiMartino's piece this morning, "Systemic risk is on the bubble", speaks loudly & well of her ability.

"David Weiman at A Few Euros More gives us the heads up on an item (from the Guardian Unlimited (U.K.) blog) bemoaning the rising tide of protectionism (among countries, including the U.S., that really ought to know better)."

Sorry, I meant that Daniel Davies doesn't say what you think he says, but rather:

'Basically and historically, "protectionism" (and "mercantilism" and related terms) always used to refer to tariff policy, with respect to goods markets and trade between buyers and sellers. The use of the terms to refer to policies about capital markets and ownership of companies is a new one; I spotted it beginning to arise in the FT and Economist around the beginning of the 1990s and have been writing Mr Angry letters on the subject ever since. Because capital markets "protectionism" is much less bad than the goods market type and might not even be bad at all.'

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In response to the idea of adding a tax exclusion for individually
purchased health care expenses -- in addition to the current one for
employer-provided care -- Holtz-Eakin had this to say:

I
think it's bad tax policy. We ought to have in this country a tax
system that means something. I am less in favor of tax systems that are
designed to do things other than raise revenue. We are likely to spend
a lot of money in the future. The government is likely to be bigger
than it is now -- I don't know how much -- and we need a tax system
that raises those revenues efficiently and doesn't muck up our economy
too much. Things like this are a recipe for mucky up the tax system and
the economy and so I really am nervous about that as -- from a
tax-policy perspective, and implementation perspective.

In general, I am the picture of sympathy for this sentiment. The best tax code is one that has low marginal tax rates and a broad base. That latter requirement means that there should be minimal use of the tax code as a tool for social engineering (or, worse, political gain).

But I make an exception for health care. The fact is that we are not talking about simply adding a distortion that was previously nonexistent. Distortions are already present in the form of tax preference for employer-provided health insurance expenditures. As Andrew Samwick emphasizes in his related Wall Street Journal debate with Mark Thoma, the idea of the tax-preferred accounts to finance out-of-pocket expenditures is designed to eliminate the perverse incentives created by subsidizing insurance with low deductibles, and to improve the portability of health care provisions.

I gather that Dr. Holtz-Eakin would prefer that we address the problem by eliminating all tax preferences of this sort, and there I am somewhat sympathetic. A preferable course might well be to address some of the regulatory issues that Andrew discusses (such as making health care coverage mandatory) and dealing with the availability of coverage to the poor through a straight system of transfers (although it would be mistaken to claim that this isn't mucking up the tax system to some degree). But absent the social consensus to move in that direction, something like medical saving accounts seems like a reasonable second-best strategy.

Comments

Logically one could combine accounts with removal of tax exemptions for employer paid healthcare moving to a system of individual coverage that could be had regardless of employer. That would be an improvement over the current system, but would people be happy with individual versus group policies? The healthy likely would and the unhealthy likely would not.

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